Tariffs - Business in United States of America
Definition: Taxes on foreign imports and exports levied by national governments
Significance: During the formative years of the United States, tariffs were very important to the growth of the economy. By imposing tariffs on imports, the United States was able to protect its fledgling manufacturing industry and encourage expansion in various sectors. The tariffs raised the price of cheaper foreign goods, especially those manufactured in England, and encouraged consumers to purchase domestic goods. This protectionist policy was instrumental in the development of the United States as an industrial country. Until the beginning of the twentieth century, tariffs were an important means of raising government revenue.
Political cartoon taking the view that the Tariff of 1846 means the death of free trade. (Library of Congress)
The United States government collects tariffs on imports; however, it does not collect tariffs on exports, as this practice is prohibited by the U.S. Constitution. Tariffs usually have both a revenue effect and a protective effect, but some tariffs are for revenue only. These are tariffs that are collected on imported products that are not produced in the importing country. Tariffs whose primary function is to protect one or more domestic industries in the importing country by raising the price of imported products that are the same as those produced domestically produce government revenue as well as having a protective effect. If tariffs become excessively high, they can curtail all importation of a product and thus lose their revenue-raising effect.
Tariffs are computed in three different ways. A tariff may be ad valorem, specific, or a combination of ad valorem and specific. An ad valorem tariff imposes a tax equal to a percentage of the selling price of the import. A tariff that is specific imposes a fixed or set amount of tax on each unit of the imported product sold without regard to the selling price. A tariff may also be a combination tariff that imposes both an ad valorem tax and a specific tax on an imported product.
The tariffs charged on imports from various countries with which one country trades are not the same. A country often grants the status of most favored nation to certain of its trading partners. After entering into such an agreement, the country pledges not to charge the most-favored nation tariffs on any goods that are higher than those charged on any similar goods imported from any other country.
Developing countries at times receive special tariff rates on certain products. Certain other countries may also receive special tariff rates through special negotiations. These rates can be lower than most-favored-nation rates. They apply to products not imported from most-favored nations. A general system of preference also at times provides preferential lower tariff rates. Industrialized countries often use these preferential rates to assist developing countries to build a healthy, stable economy.
Advantages and Disadvantages
Tariffs are advantageous to a country in that they provide revenue and protect and encourage domestic production. The increase in production provides more jobs for the country’s workers and contributes to a higher standard of living. Tariff rates do not always have to be high to be beneficial to a country. Preferential lower tariffs under the general system of preference not only are beneficial to a developing country but also have an advantage for the industrialized nation granting them. By granting lower rates, the industrialized country becomes a trading partner of the developing country. Encouraged to produce and export more goods, the developing country ameliorates its economy, with the result that it is able to import more goods from its trading partner, the industrialized nation. The increased trade has a positive effect on the economies of both countries.
However, tariffs are not without disadvantages. Tariffs that increase the cost of lower-priced similar imported goods and thus protect domestic producers, encourage more production, and create jobs, would appear to be very advantageous. However, this is not the case. Such tariffs cause the consumer to pay higher prices for the particular product protected by the tariff. Thus, the cost of the additional jobs created may be very high per job.
High tariffs can also instigate retaliatory measures by trading partners. If a country imposes high tariffs on goods imported from its trading partners, they will probably impose similar high tariffs on the goods they import from the high-tariff country. This reciprocal imposition of high tariffs then severely limits trade between the countries and may bring it to a standstill.
In general, those who produce goods for the domestic market benefit from tariffs. Those involved in producing goods include manufacturers, entrepreneurs, workers in various industries, and agricultural producers. As long as the domestic market provides a level of consumerism adequate to use the amount produced and maintain prices, these individuals are going to support tariffs and encourage the passage of high tariffs to eliminate foreign competition. However, if the domestic market is unable to consume the production and a surplus results, these same commercial entities or groups may not benefit from high tariffs. With a surplus of goods, there is a need for a larger market than that provided within the country. High tariffs on imports into one country tend to create high tariffs on that country’s exports to other countries. Thus the greater world market does not readily open to the producers who are seeking new markets.
Tariffs in the United States
Tariffs have played an important role in the history and the economic development of the United States. In the seventeenth century when America was still a colonial possession, England, in an effort to protect British commercial interests, imposed high tariffs on the major exports of the northern colonies, fish and grain in particular. These tariffs forced the colonists to find new markets in theses Indies and in southern Europe.
After the colonies became an independent nation, tariffs were used to raise revenue and pay the debt incurred during the Revolutionary War. In 1789, under the leadership of Alexander Hamilton, the country imposed an ad valorem tariff of 8 percent on thirty different commodities and of 5 percent on all other goods.
The first protective tariff was passed by Congress in 1816. Henry Clay convinced the members of Congress that true economic independence from Europe depended on increasing American manufacturing. Persuaded that prohibiting or substantially reducing the import of cheaper European goods, especially from England, would aid in developing manufacturing, Congress passed a tariff to create a protected domestic market.
By the mid-nineteenth century, tariffs had become a divisive issue between the northern and southern states. The North, interested in developing a large manufacturing industry, favored high tariffs, while the South, whose farmers and plantation owners needed to export large crops of cotton and tobacco, were in favor of lower tariffs that would encourage trade and lower tariffs on their crops to other countries.
Higher and Higher Tariffs
In 1828, Congress passed the Tariff of Abominations, also known as the Tariff of 1828. With the implementation of this new tariff, United States tariffs became the highest in the world. The tariff exasperated the southern states. It caused severe problems for southern exporters who relied on England as their primary trading partner. All English exports to the United States were subject to excessively high tariffs.
The Tariff Act of 1832 made some reductions in the tariff. Then on March 1, 1833, the Compromise Tariff Act provided for the tariff to be reduced gradually to 20 percent by 1842.With the secession of the South from the Union, high tariffs once again became the rule. In 1861, northern manufacturers were favored with passage of the Morrill Act. This tariff legislation set the policy that continued into the mid-1930’s. High taxes on imports protected the nation’s manufacturers and entrepreneurs as it built itself into the major industrial nation of the world. With free passage of goods in interstate commerce, an abundance of natural resources, an effective railroad system, and freedom from foreign competition, the nation’s economy thrived. By 1900, the domestic market was purchasing 97 percent of its manufactured goods from domestic producers. The high tariffs on imports were not only protecting the domestic market but also providing half of the federal revenue as late as 1910.
Congressmen continued to be influenced by isolationist and protectionist groups through the first third of the twentieth century. During President Herbert Hoover’s administration, several factions were demanding higher tariffs on imports. The farmers and agricultural interests who were suffering from low farm prices were calling for high tariffs on agricultural products. They were soon followed by manufacturing interests in demands for tariffs. Soon, protective tariffs were the main issue in all political discussion. On June 17, 1930, with the enactment into law of the Smoot-Hawley Tariff Act, the obsession with excessive tariffs reached its apex. This was the last general tariff passed by Congress and also the highest in the nation’s history. It raised tariffs to 60 percent of the selling price of imports. This tariff brought about the collapse of American exports, as foreign governments retaliated with high tariffs on American imports. Eventually forty countries raised their tariffs.
United States Total Merchandise Trade with Free Trade Nations, 2005-2007, in Millions of Dollars
Source: Data from United States International Trade Commission, The Year in Trade 2007 (Washington, D.C.: Author, 2008)
Note: Free trade nations are Australia, Bahrain, Chile, DR-CAFTA, Israel, Jordan, Morocco, NAFTA, and Singapore. Trade data are from the U.S. perspective.
A Major Change in Policy
The Great Depression and World War II caused a serious interruption to world trade. This interruption to trade brought about a rethinking of trade policy and of the role the United States was to play in relation to trade with other countries. President Franklin D. Roosevelt began negotiation talks with the major trading partners of the United States. The purpose of the negotiations was to bilaterally lower trade barriers, including tariffs. In 1934, the Reciprocal Trade Agreements Act was passed. The United States had a new attitude toward trade and a new trade policy. During the 1940’s, the General Agreement on Tariffs and Trade (GATT) provided rules of conduct for trading, set the stage for the lowering of trade barriers, especially tariffs, and provided an arena for resolving trade disputes between countries. Under the GATT, a series of rounds of negotiation talks to lower trade barriers began in 1947 and have continued to effectively lower tariffs. In addition, the United States has entered into free trade agreements such as the North American Free Trade Agreement (NAFTA). The heavy reliance on excessively high protective tariffs that dominated U.S. trade with other countries is no longer a part of American trade policy.
Destler, I. M. American Politics. 4th ed. Washington, D.C.: Institute for International Economics, 2005. This comprehensive revision of a work recognized as the best book on national policy by the American Political Science Association discusses the shift from protective tariffs to labor and environmental concerns. Also proposes ways that the United States can maximize the benefits of globalization.
Eckes, Alfred E., Jr. Opening America’s Market: U.S. Foreign Trade Policy Since 1776. Chapel Hill: University of North Carolina Press, 1995. Good overview of history of American trade and trade policies from the country’s inception as a nation. Gives special attention to the Underwood Tariff Act of 1913 and the Federal Tariff Commission.
Ekelund, Robert B., Jr. Tariffs, Blockades, and Inflation: The Economics of the Civil War. Lanham, Md.: Rowman & Littlefield, 2004. Provides a sharp contrast between the trading situations in a single nation- oriented atmosphere of trade and a global trading community. Explains how the United States used tariffs and other barriers to trade during a war and the resulting effects on the economy.
Northrup, Cynthia Clark, and Elaine C. Prange Turney, eds. Encyclopedia of Tariffs and Trade in U.S. History. Westport, Conn.: Greenwood Press, 2003. An informative collection of more than four hundred entries on the tariff acts passed by Congress between 1789 and 1930. Includes primary sources and the texts of the tariffs themselves.
Schott, Jeffrey J., ed. Free Trade Agreements: U.S. Strategies and Priorities. Washington, D.C.: Institute for International Economics, 2004. Edited by a member of the U.S. delegation to the Tokyo Round of the GATT agreements, this study is one of the most thorough presentations of the United States’ participation in free trade agreements. It deals extensively with NAFTA and elucidates why free trade agreements are replacing tariffs.
Taussig, Frank W. The Tariff History of the United States. New York: Augustus M. Kelley, 1967. This classic by a Harvard economics professor and the foremost authority on tariffs until 1935 discusses the highly protective Dingley Tariff and tariffs of the early twentieth century. Taussig, a reluctant supporter of free trade but an opponent of unions, is credited as the founder of international trade theory. Also addresses the danger of retaliation by trading partners when excessively high tariffs are enacted.